In 2008, IVRCL Ltd. (then named IVRCL Infrastructure & Projects) was a formidable player in the field of construction, operating in various infrastructure segments including roads, irrigation, water, buildings, power etc., with a credit rating of AA- by India Ratings & Research (Fitch Ratings).

When it was downgraded to A- in 2011, the company was still a strong player in its field with on-hand projects of a water desalination plant, seven BOT road projects and order book of nearly ₹20,000 crore. In August 2013, it was downgraded to ‘D”, reflecting the default in loan servicing and slowdown in project execution. As on date, the company’s shares are suspended from trading on bourses. It is the first company to be liquidated as a going concern under Insolvency and Bankruptcy Code. This sums up the plight of most of the construction companies in India.

There are two critical issues involved in the fall of IVRCL — firstly, this will render the banking system poorer by ₹14,000 crore due to the write-off of debt/investments. Secondly, an infra conglomerate with a repository of pre-qualifications/expertise is getting extinguished.

There are many such companies, of varying sizes, reeling under the threat of winding up. The fact that, as on date, 421 construction companies have been admitted under Corporate Insolvency Resolution Process (CIRP) triggered by various stakeholders highlights the enormity of the devastation. The impact has been multifarious, including the erosion of balance sheets of various banks which had exposure to this sector and loss to the exchequer due to the depletion of its investment value in these public sector banks and the stalled projects.

There is an immediate need understand what went wrong with these construction companies and to readjust the ecosystem.

PPP model – Before & after

‘Public Private Partnership (PPP)’ was introduced to address the issue of limitations of public funding for the development of roads.

Prior to introduction of PPP model, road projects were executed on EPC (Engineering, Procurement and Construction) basis wherein the contractor carried the execution risk. The lowest bidder was awarded the contract, upon which he was required furnish the Performance Bank Guarantee (PBG) and a Financial Bank Guarantee (FBG) for the Mobilization Advance (MA).

The working capital assistance from the banks for a typical EPC contract was limited to Bank Guarantees limits and small limit of Letter of Credit (LC). The Mobilisation Advance released at the start of the contract was largely sufficient for the contractor to kick start the works and a regular billing cycle had taken care of the working capital needs.

At the same time, the Indian banking landscape was witnessing lot of changes with the entry of private sector and foreign banks. The two largest institutional lenders (IDBI and ICICI) were transformed into the commercial banks. This resultant competition amongst banks brought in changes in the lending practices. The requirement of 25 per cent of cash margin and additional collateral security for sanctioning the BG/LC limits was relaxed. This cash margin and security, which were mitigants for exposure risk of the banks, also acted as a deterrent against any reckless bidding because of the limited availability of BGs.

The easy availability of BGs led to aggressive bidding changing the dynamics of project execution. In fact, with the release of mobilisation advance against a BG, the entire risk got transferred to banks. The maximum damage to the contractor due to a termination of project was the black-listing by principal for a period of one year.

As most of these EPC contractors possessed the requisite pre-qualifications, they started bidding aggressively for the BOT projects with lack of complete understanding of the risks associated with them.


Underestimation of risks

Various risk factors associated with this model have been overlooked by all the stakeholders — the government, contractor and lending bank.

(i) Firstly, the viability of the project was established based on various assumptions such as growth in traffic, movement in inflation/interest rates etc., stretching over a long period, which turned out be hugely optimistic.

(ii) These projects were implemented by bidders through SPVs floated for the purpose, which are subsidiaries of the EPC company (parent). In order to raise the project debt at SPV level, they entered into a fixed price contracts with the parent which means that any loss on account cost overruns will accrue at the parent level. Lost in the din was the requirement of equity margin for the project funding, which was largely manipulated through accounting jugglery.

(iii) These projects were generally funded by bankers who were also present at the parent level. This over exposure triggered a vicious circle with banks staring at NPAs at both levels – i.e., parent and SPV.

(iv) Some of the large EPC companies had too many PPP projects on their plates that they had no bandwidth (in terms of resources and working capital support) left to take-up any fresh EPC contracts.

(v) Bank Guarantees, which were considered as risk-free non-fund-based instruments, started crystallizing into funded exposure because of the rampant invocations.

(vi) Many of the EPC companies, which had negligible debt prior to taking up the PPP projects had to raise Cash Credit/Overdraft limits to the tune of 40 per cent, which is not at all a viable working capital arrangement. The interest costs adding to the burgeoning operating losses started eroding balance sheets.

(vii) In order to keep the company going, most of these players resorted to accounting jugglery by including the ‘unbilled revenue’ as part of the revenues which camouflaged the balance sheets for couple of years.

Failure of the Corporate Debt Restructuring (CDR) mechanism and subsequently introduced revival packages accentuated the death of these EPC companies.

Death of these EPC companies means the death of pre-qualifications and expertise accumulated over a period of time which in turn will have a telling impact on the infrastructure development of the country.

The writer is a corporate banking professional in a leading private sector bank